Teachers’ Retirement System of the State of Illinois

a component unit of the State of Illinois

COMPREHENSIVE ANNUAL FINANCIAL REPORT For the Fiscal Year Ended June 30, 2017

MISSION STATEMENTTRS will continually deliver the retirement security promised to our members by maintaining the highest and most efficient level of service and by living our values:

• Put the best interest of others first

• Diversity

• Teamwork

• Continuous improvement

FISCAL YEAR 2017 HIGHLIGHTS

As of June 30, 2017

Active contributing members 160,488

Inactive noncontributing members 131,812

Benefit recipients* 120,151

Total membership 412,451

Investment return

Total fund investment return, net of fees 12.6%

For funding purposes

Actuarial accrued liability (AAL) $122,904,034,268

Less actuarial value of assets (smoothed assets) 49,467,525,209

Unfunded actuarial accrued liability $73,436,509,059

Funded ratio (% of AAL covered by assets, based on smoothed assets) 40.2%

For financial disclosure

Total pension liability (TPL) $125,773,806,438

Less fiduciary net position (FNP) 49,375,664,518

Net pension liability (NPL) $76,398,141,920

FNP as a percentage of TPL 39.3%

Income

Member contributions $929,130,165

Employer contributions 149,495,577

State of Illinois contributions 3,986,363,699

Total investment income 5,520,453,001

Total income $10,585,442,442

Expenses

Benefits paid $6,152,867,751

Refunds paid 285,138,169

Administrative expenses 22,728,735

Total expenses $6,460,734,655

* Benefit recipients includes retiree, disability and survivor benefit recipients.

Cover photo credit: Tom Lee

P R E F A C ET E A C H E R S ' R E T I R E M E N T S Y S T E M

O F T H E S T A T E O F I L L I N O I Sa c o m p o n e n t u n i t o f t h e S t a t e o f I l l i n o i s

2815 West Washington | P.O. Box 19253 | Springfield, Illinois 62794-9253 | http://www.trsil.org

COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED JUNE 30, 2017 This report was prepared by the TRS Accounting, Investments, Research and Communications Departments.

Peoria Riverfront Museum Established in 2012, the Peoria Riverfront Museum brings together a wide-ranging collection of exhibits, many with connections to the greater Peoria area. The museum explores the ecology and importance of the Illinois River and contains one of the first mass-produced, gasoline-powered cars in the United States – the Peoria Duryea Motor Trap. The complex includes a planetarium, a sculpture garden, an interactive “Discovery Worlds” area for children as well as artifacts and displays outlining the history of Peoria. 222 SW Washington Street, Peoria | www.peoriariverfrontmuseum.org

http:http://www.trsil.orghttp://www.peoriariverfrontmuseum.org

Photo credit: David Siede/DefinedSpace.com

Illinois Holocaust Museum and Education Center The guiding theme of the Illinois Holocaust Museum and Education Center, established in 2009, is “Remember the Past, Transform the Future.” With more than 65,000 square feet and 500 artifacts, documents and photos, the museum guides visitors through the horror of the Holocaust during World War II, as well as genocides that have plagued the world in more recent history. The museum honors the millions of victims that perished during the Holocaust, as well as the courage of survivors. 9603 Woods Drive, Skokie | www.ilholocaustmuseum.org

LEARNING BEYOND THE CLASSROOM FIELD TRIP! For generations of school children, those words are magic.

Leaving their familiar classroom to visit a museum, nature center, historic site or place of business has always generated excitement.

For generations of Illinois teachers, field trips have always created challenges –shepherding their flocks safely in strange environments and bringing the lessons of theexcursion back to the classroom.

But for everyone, there’s little doubt that exposing students to unique, in-personexperiences stimulates learning and can trigger motivation for the future.

The State of Illinois is blessed with a multitude of educational opportunities that enrichstudents of all ages. From historic sites that have existed since prehistoric times tomonuments and museums that bring to life local, national and international events, Illinoisstudents can immerse themselves in the past, relive the wonder of discovery and even geta glimpse of what the future may hold for them.

Within this Comprehensive Annual Financial Report for fiscal year 2017, Teachers’Retirement System is proud to highlight just a few of the places in Illinois that helpteachers and students extend learning beyond the classroom.

Elgin History Museum (on the cover) Housed in an 1856 building that used to serve as the “Old Main” of Elgin Academy campus, the museum traces the cultural, commercial and community history of Elgin since its settlement in 1832 on the stagecoach route between Chicago and Galena. Exhibits include an extensive collection of Native American artifacts and memorabilia from the nationally-famous Elgin National Watch Company. 360 Park Street, Elgin | https://elginhistory.org

http:https://elginhistory.orghttp:www.ilholocaustmuseum.orghttp:Siede/DefinedSpace.comhttp://www.ilholocaustmuseum.orghttps://elginhistory.org

TABLE OF CONTENTS PREFACE

INTRODUCTION 4 Certificate of Achievement 5 Recognition Award for Administration 6 Letter of Transmittal 13 Board of Trustees 14 TRS Organization 15 Consulting and Professional Services

FINANCIAL 18 Independent Auditor's Report 20 Management’s Discussion and Analysis 26 Financial Statements

Statement of Fiduciary Net Position June 30, 2017

27 Statement of Changes in Fiduciary Net Position for the Year Ended June 30, 2017

28 Notes to Financial Statements 56 Required Supplementary Information

Schedule of Changes in the Net Pension Liability for Fiscal Years Schedule of the Net Pension Liability for Fiscal Years Schedule of Investment Returns for Fiscal Years

57 Schedule of Contributions from Employers and Other Contributing Entities, Last 10 Fiscal Years Notes to Required Supplementary Information

58 Other Supplementary Information Schedule of Administrative Expenses for the Years Ended June 30

59 Schedule of Investment Expenses for the Years Ended June 30

60 Schedule of Professional Services for the Years Ended June 30

INVESTMENTS 62 Introduction 63 Asset Allocation 64 Portfolio Securities Summary 65 Securities Holdings (Historical) 65 Investment Results 67 Global Public Equities 69 Private Equity

72 Global Fixed Income 75 Real Estate 77 Real Assets 78 Diversifying Strategies 79 Securities Lending 80 Brokerage Activity 81 Investment Manager and Custodian Fees

ACTUARIAL 86 Actuary’s Certification 88 Actuarial Assumptions and Methods 90 Annual Actuarial Valuation 91 Analysis of Financial Experience:

Reconciliation of unfunded Liability 92 Actuarial Standards and Illinois State Pension

Funding State Funding

94 Tests of Financial Condition 95 Other Information 97 Funding Analysis by Tier 99 Average Annual Salary for Active Members

(Excluding Substitutes) by Years of Service and Number of Employees

100 Average Annual Salary and Age for Active Members by Years of Service as of June 30, 2017

101 Plan Summary 102 Summary of Tier I and Tier II Benefit Provisions

STATISTICAL 106 Statistical Section 107 Changes in Net Position Restricted for Pensions,

Last 10 Fiscal Years 108 Benefit and Refund Deductions from Net Position

by Type, Last 10 Fiscal Years 109 Employee and Employer Contribution Rates, Last

10 Fiscal Years Active Members by Tier

110 Retired Members by Years of Service and Years in Retirement as of June 30, 2017

111 Demographics of Benefit Recipients and Active Members as of June 30, 2017

112 Benefit Recipients by Type as of June 30, 2017 113 Average Benefit Payments for New Retirees, Last

10 Fiscal Years 114 Principal Participating Employers

INTRODUCTION

William Fithian Home / Vermilion County MuseumIn September of 1858, Abraham Lincoln brought his ill-fated campaign for the U.S. Senate to Danville and the home of Dr. William Fithian, who had been a friend since their days together in the Illinois General Assembly. Following a political rally, Lincoln climbed through a second-floor window and spoke from a balcony to a crowd gathered outside. Today, students can see the bed that Lincoln slept in during his visit and walk on the same floorboards that the future president trod 159 years ago. The Fithian Home is adjacent to the Vermilion County Museum, which is designed to resemble the old county courthouse built in 1833. 116 North Gilbert Street, Danville | www.vermilioncountymuseum.org

Introduction - page 4

P CP C Public Pension Coordinating Council

Recognition Award for Administration 2017

Presented to

Teachers’ Retirement System of the State of Illinois In recognition of meeting professional standards for

plan administration as set forth in the Public Pension Standards.

Presented by the Public Pension Coordinating Council, a confederation of

National Association of State Retirement Administrators (NASRA) National Conference on Public Employee Retirement Systems (NCPERS)

National Council on Teacher Retirement (NCTR)

Alan H. Winkle Program Administrator

Introduction - page 5

TEACHERS’ RETIREMENT SYSTEM OF THE STATE OF ILLINOIS 2815 West Washington Street | P.O. Box 19253 | Springfield, Illinois 62794-9253 Richard W. Ingram, Executive Director http://www.trsil.org 877-927-5877 (877) 9-ASK-TRS

LETTER OF TRANSMITTAL December 12, 2017

To the Board of Trustees and TRS Members:

We are pleased to present the Comprehensive Annual Financial Report (CAFR) for the Teachers’ Retirement System of the State of Illinois (TRS) for the fiscal year ended June 30, 2017. This report highlights the on-going work of TRS trustees and staff to be widely recognized as a premier public retirement system in the United States with an absolute commitment to its members, a dedication to the highest standards of service, public accountability and the ability to overcome any challenge.

RESPONSIBILITIES OF TODAY For 78 years, TRS has consistently fulfilled its statutory mission to deliver the retirement security promised by the State of Illinois to all of its members. During FY17:

• TRS distributed $6.2 billion in retirement, disability and survivor benefits to more than 120,000 annuitantsand beneficiaries.

• TRS benefit payments largely stayed in Illinois and created economic activity throughout the statethat helped support more than 41,000 jobs. These jobs have an estimated payroll of $1.6 billion. In all,economic models show that TRS benefits created a $3.8 billion economic boost to the State of Illinois.

• TRS investments continued to perform well over the short-term and long-term. The TRS portfoliorecorded a positive 12.6 percent rate of return, net of fees, during FY 2017, which exceeded theSystem’s investment benchmark of 11.4 percent. The portfolio’s 30-year annualized return rate was apositive 8.1 percent, net of fees. This exceeded the 7 percent long-term actuarial return assumptionestablished by the Board.

• TRS successfully handled more than 1 million telephone calls, emails, other correspondence andcounseling sessions with members and employers.

TRS maintained its focus on its members in FY17 despite the uncertainty that accompanied a prolonged parti-san dispute between the executive and legislative branches of state government over the enactment of a state budget. In early July 2017, the General Assembly enacted a budget for FY18 after two fiscal years without a legal spending outline.

TRS fared better during the dispute than most state government entities because its operations are self-funded and the annual contribution from the state to fund benefits is automatically approved by a continuing appropriation. TRS received its full statutorily-required funding contribution for FY17 of $4.0 billion.

However, despite the enactment of a new state budget for FY18, the dispute compounded existing revenue and spending problems that have plagued state government for the last decade. Bringing long-term fiscal

Introduction - page 6

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order to Illinois will require a reconfiguration of many programs and services and a potential reduction in funding for state operations. As part of the budget agreement, several substantial changes were made to the state’s Pension Code that are intended to reduce the cost of public pensions to state government and, over time, to fundamentally change the state’s retirement promise to future TRS members.

CHALLENGES FOR THE FUTURE Provisions in the FY18 budget legislation affecting TRS create a Tier III hybrid retirement plan that would include a defined benefit pension supplemented by a defined contribution plan. The details of implementing Tier III are currently under review. After Tier III is implemented, all new hires will be covered by the new plan unless they elect to participate in Tier II. The earliest possible effective date for Tier III is July 1, 2019.

In addition, new laws were enacted that change the statutory calculation of the state’s annual contribution to fund benefits.

• Beginning in FY18, TRS must smooth, over a five-year period, the fiscal effect of any changes made to theTRS actuarial assumptions made since 2012. This has the effect of reducing the FY18 state contribution byapproximately $500 million.

• School districts will assume a greater share of the cost of a member’s pension by paying a contribution onthe portion of a member’s salary greater than the governor’s statutory salary, which in FY17 was $177,412.

• For teachers whose salaries are funded by federal grants, school districts will contribute to TRS anamount equal to the employer’s normal cost, and not legacy costs attributable to the TRS unfunded liabil-ity, as had been the case.

It is worth noting that as TRS tackles these challenges, turnover on the TRS Board of Trustees has been signif-icant. Two appointed seats on the 13-member Board are currently open, four new trustees were appointed in FY17 and several elected members have relatively short tenures.

The long-term funded status of TRS continues to be among the worst in the nation. At the end of FY17, the System’s funded ratio was 40.2 percent, on an actuarial basis, with a long-term unfunded liability of $73.4 billion. The unfunded obligations owed to members have increased by 544 percent since 2000.

For purposes of financial disclosure, the plan fiduciary net position as a percentage of the total pension liabil-ity was 39.3 percent with a net pension liability of $76.4 billion. TRS ranks as the 82nd largest pension fund in the world when measured by assets under management with a net position of $49.4 billion at the end of FY17. However, if TRS was fully funded, the System would rank within the top 20 pension systems worldwide and among the top 10 U.S. funds.

Since TRS was founded in 1939, the State of Illinois has never, in any year, funded the System at a level that standard actuarial practice would define as sufficient to pay its full share of the annual normal cost. This is troubling because the investment returns from the TRS portfolio are not enough to fill the funding gap. TRS is dependent on the state’s annual contribution for its future solvency. The contribution in FY17 was $4.0 billion, which is approximately 10 percent of the state’s total General Funds appropriation. The size of the allocation to TRS is a self-inflicted problem. Approximately 80 percent of the state’s $4.0 billion annual contribution to TRS in FY17 was dedicated to paying off a portion of the System’s unfunded liability. Had the state funded TRS on a sound, actuarial basis over the years, the state would have owed approximately $800 million for TRS pen-sion costs in FY17, leaving $3.2 billion available for other spending priorities.

While TRS remains an influential institutional investor, over time its growing unfunded liability threatens the System’s ability to continue to earn the investment returns that are vital to the security of TRS.

Introduction - page 7

In FY17, all 199 TRS staff remained committed to the goal of unparalleled customer service for its 412,451 members and 989 employers. The System’s Member Services Department processed approximately 9,000 benefit applications for members, held close to 6,800 individual member counseling sessions and calculated nearly 49,000 initial benefit estimates upon request. The TRS Employers Services Department processed annual reports from 989 employers covering approximately 160,500 active members and conducted audits of 90 school districts to ensure compliance with all laws, rules and standards. TRS staff initiated or received more than 790,000 letters, 211,000 telephone calls and 23,000 emails from employers and members or their families.

TRS remained dedicated to the prudent use of the System’s assets to perform required duties and activi-ties on behalf of its members. Administrative expenses for all of TRS decreased by 1 percent during FY17 to $22.7 million, or 0.04 percent of all TRS assets. Total expenses to manage the investment portfolio increased by 3.8 percent to $779.6 million, or 1.59 percent of all TRS investments.

PROFILE OF TRS TRS was established by the State of Illinois on July 1, 1939, to provide retirement, disability, and death ben-efits to teachers employed by Illinois public elementary and secondary schools outside the city of Chicago. A 13-member Board of Trustees governs TRS. The Board includes the state superintendent of education, six representatives of the public who are appointed by the governor, four members of TRS who are elected by active teachers, and two retired members who are elected by annuitants. The Board of Trustees appoints the executive director, who is responsible for the effective administration of TRS.

The annual budget for TRS administrative expenses is prepared by staff and approved by the Board of Trustees. The TRS annual operating budget request is prepared in conjunction with a review of the long-range strategic plan.

FINANCIAL INFORMATION Our staff issues a CAFR within six months of the close of each fiscal year. The report contains financial state-ments presented in conformity with generally accepted accounting principles (GAAP) applied within guide-lines established by the Governmental Accounting Standards Board (GASB).

A system of internal controls helps us monitor and safeguard assets and promote efficient operations. Each year TRS’s financial statements, records, and internal controls are examined by a professional accounting firm that serves as a special assistant auditor employed by the Illinois Auditor General. In addition, an annual compliance attestation examination is performed to review compliance with applicable statutes and codes. The Independent Auditor’s Report on TRS’s financial statements is included on pages 18 and 19 in the Financial Section of this report. TRS received an unmodified auditor opinion on the fair presentation of its financial statements.

Generally accepted accounting principles require that management provide a narrative introduction, overview and analysis to accompany the financial statements in the form of a Management’s Discussion and Analysis (MD&A). This letter of transmittal is designed to complement and should be read in conjunction with the MD&A, which can be found immediately following the report of the independent auditors.

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REVENUES AND EXPENSES The three sources of TRS funding are member contributions, investment income and employer contribu-tions through State appropriations and payments by employers. TRS expenses include payments of benefits, refunds and administrative expenses. Negative amounts are shown in parentheses () throughout this report.

Revenues ($ millions) Expenses ($ millions)

Source 2017 2016

Increase/(Decrease)

2017 2016

Increase/(Decrease)

Amount % Change Amount % Change

Member contributions $929 $952 ($23) (2.4%) Benefits payments $6,153 $5,848 $305 5.2%

State of Illinois 3,986 3,742 244 6.5 Refunds 285 83 202 243.4

Employer contributions 149 148 1 1.0 Administrative/ other 23 23 - -

Total investment income/(loss) 5,521 (44) 5,565 12,617.1 Total $6,461 $5,954 $507 8.5%

Total $10,585 $4,798 $5,787 120.6%

The TRS Board of Trustees and staff remain vigilant in our efforts to improve the retirement system’s funded status for current and future members. We continue to invest prudently and in a disciplined manner for the benefit of our membership and for the long-term success of the retirement system. The TRS Board and staff believe the overall investment strategy remains sound and appropriate for our circumstances.

INVESTMENTS The TRS investment portfolio returned 12.6 percent, net of fees, for the fiscal year ended June 30, 2017. Total investment assets increased approximately $3,547 million during the year.

The TRS trust fund is invested under the authority of the Illinois Pension Code and follows the “prudent person rule,” which requires investments to be managed solely in the interest of fund participants and beneficiaries. The TRS Investment Policy guides TRS’s investments. Investment principles include preserving the long-term principal of the trust fund, maximizing total return within prudent risk parameters and acting in the exclusive interest of TRS members.

The Investment Section of this report contains a summary of the portfolio and investment activities. Pages 80 to 83 provide specific details regarding fees and commissions and a list of investment professionals who pro-vided services to TRS.

FUNDING During the year ended June 30, 2017, the funded ratio based on the actuarial value of assets of the Teachers’ Retirement System increased to 40.2 percent from its June 30, 2016 level of 39.8 percent. The actuarial value of assets at year end was $49.5 billion and the actuarial accrued liability was $122.9 billion. Under the smoothing methodology required by Public Act 96-0043, differences between actual and expected investment earnings are recognized prospectively over a five-year period.

The Actuarial Section of this report contains the actuary’s letter and further information on funding.

MAJOR INITIATIVES WEB-BASED MEMBER REFUNDS TRS successfully implemented one of its most daunting information technology projects in recent memory – the conversion of systems and processes required by the sunset of the System’s Early Retirement Option

Introduction - page 9

(ERO) in July of 2016. More than 200,000 members were eligible for the refund, which presented a tremendous challenge for the System in receiving, processing, recording and authorizing payment.

TRS set up an online application system to process the requests for ERO Sunset Refunds, a task made more difficult because members have the option of receiving a cash payment or rolling over the refund into a sep-arate retirement account. TRS processed 98,990 ERO Sunset Refunds totaling more than $201 million during FY17. Of those requests, 71 percent were completed entirely through the online application system.

With this ERO legislative change, the member contribution rate decreased from 9.4 percent to 9.0 percent.

COMMITMENT TO DIVERSITY TRS continues to strengthen its existing commitment to diversity within the management of its $49.2 billion investment portfolio. The TRS Board of Trustees has made a commitment to improving access to the invest-ment program for qualified firms owned by women, minorities and those with disabilities, called Women/ Minority Business Enterprises (WMBE). The System hosts an annual Opportunity Forum that is the cornerstone of these efforts.

TRS assets managed by WMBE firms totaled $8.9 billion or 18.2 percent of total plan assets, exceeding the participation goal of 17 percent. TRS continues to benefit from relationships started within the System's Emerging Manager Program, as well as continued growth in minority managers within the main portfolio.

The System’s commitment to diversity is not limited to its investment practices. TRS also seeks to increase diversity among vendors providing administrative goods and services. As of June 30, 2017, 18.6 percent of expenditures subject to the goal were paid to business enterprise vendors, far exceeding the goal of 10 percent. The goal for FY18 remains at 10 percent with a long-term goal of 20 percent.

WEBSITE REDESIGN TRS planned, designed and developed a website that is easy to navigate and more intuitive than previous versions. TRS received input from staff, members, stakeholders and colleagues in the public pension community. This information was used to build an inviting, efficient and uncomplicated website. The new design is geared toward helping members complete specific tasks and will grow over time to provide members with other services to simplify their business with TRS.

DOMAIN NAME CHANGE AND EMAIL ADDRESS CHANGE In June, TRS changed its internet domain name from trs.illinois.gov to www.trsil.org. This was a significant and far-reaching initiative that essentially submitted a change of address to the worldwide web. The change will afford TRS greater flexibility as the System moves forward in modernizing its technology.

TELECOM AND DATA CONNECTION TRANSFER TRS enhanced its data and telecom services through a new relationship with AT&T, which is administered independently of the state government system. As a result of this new relationship, TRS changed all internal and external phone numbers, along with all toll-free numbers. This change increases TRS's ability to continue operations in the event of a disaster, provides greater flexibility to network changes, increases capacity and reduces the overall costs associated with providing these services.

BENCHMARKING TRS completed its fourth consecutive annual benchmarking study as a client of CEM Benchmarking, Inc. of Toronto, Canada, an international consulting firm that provides public pension systems with a variety of metrics to help leaders determine how well their systems are performing compared to peers. These metrics

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analyze operations, member services, and information technology. TRS also completed its third year of partic-ipation in CEM’s investment benchmarking study.

TRS operational costs remain below the peer average while service scores continue to achieve steady and sig-nificant improvement. Call wait times have declined and staff productivity remains higher than our peer aver-age. For the investment portfolio, the CEM study showed that TRS returns exceed the U.S. peer median while the asset risk for the TRS portfolio was lower than that of our U.S. peers.

ON-GOING TECHNOLOGY PROJECTS Custom benefit solution – During FY17, the State of Illinois outsourced the administration of the govern-ment’s group health insurance plans to a third-party vendor. This was a decision beyond the control of TRS and affected the System’s retired members, along with the members of other state pension systems and active government employees.

However, since the October 1, 2016 conversion date, there have been serious and recurring problems with the transition of the insurance administration. As this letter is written, TRS still is not able to process a complete monthly benefit payroll through the third-party administrator. Only an extraordinary effort by TRS staff miti-gated the impact of the change on the System’s members. This unplanned use of staff time, however, created a significant drain on TRS resources and delayed the planned start of the following projects.

Pension Administration System (PAS) – During FY17, TRS began a thorough study of the System’s internal Pension Administration System, known as STAR. The system is used daily by TRS staff for a multitude of func-tions, including the recording of member information, calculating employer bills, refunds and benefit pay-ments, as well as tracking member service and creditable earnings.

After completing the evaluation of STAR’s current capabilities and the System’s future needs, TRS staff will make a recommendation to the Board of Trustees in FY18 regarding the necessary investment in the next gen-eration of this important system.

Expenditure Resource Planning (ERP) – TRS began initial planning and discussion about the eventual replacement of its aging expenditure management and employee record systems that process all of the System’s day-to-day expenditures, financial accounting records and personnel reports. TRS has released a for-mal Request for Proposals and expects to complete the implementation of a new ERP in FY19.

Development methodology – In early 2017, TRS began the transition from typical waterfall-based software development methodology to an Agile/Scrum framework. The transition impacted the entire TRS organization because it was a complete departure from the manner in which development work was completed in the past. This change in methodology focuses on completing project deliverables incrementally and at a faster pace. Initial results show that productivity has increased by more than six times compared to previous projects.

Document imaging – The last department workflow for the System’s Member Services Department began late in FY17. Virtually all member documents are now captured into the document imaging system and require minimal paper processing.

The Member Services repository is more than 11 terabytes in size and contains more than 9 million images. The accompanying back-file conversion project is 72 percent complete with more than 275,000 imaged records. The goal is to complete the back-file document imaging project in the summer of 2018.

The document imaging project covering records for other departments at TRS continues.

Introduction - page 11

AWARDS CERTIFICATE OF ACHIEVEMENT FOR EXCELLENCE IN FINANCIAL REPORTING The Government Finance Officers Association of the United States and Canada (GFOA) awarded a Certificate of Achievement for Excellence in Financial Reporting to TRS for its Comprehensive Annual Financial Report for the fiscal year ended June 30, 2016. This was the 28th consecutive year that the System has achieved this prestigious award. In order to be awarded a Certificate of Achievement, a government or government entity must publish an easily readable and efficiently organized Comprehensive Annual Financial Report. This report must satisfy both generally accepted accounting principles and applicable legal requirements. A Certificate of Achievement is valid for a period of one year only. We believe that our current Comprehensive Annual Financial Report continues to meet the Certificate of Achievement Program’s requirements and we are submitting it to the GFOA to determine its eligibility for another certificate.

PUBLIC PENSION COORDINATING COUNCIL (PPCC), RECOGNITION AWARD FOR ADMINISTRATION TRS received the Recognition Award for Administration in 2017 for meeting professional standards of plan administration as set forth in the Public Pension Standards of the PPCC. The award is presented by the PPCC, a confederation of the National Association of State Retirement Administrators (NASRA), the National Conference on Public Employee Retirement Systems (NCPERS), and the National Council on Teacher Retirement (NCTR).

ACKNOWLEDGMENTS Information for this report was gathered by TRS staff under the leadership of the Board of Trustees and the executive director and it is the responsibility of TRS management. It is intended to provide complete and reli-able information as a basis for making management decisions, to determine our compliance with legal pro-visions and as a means of determining responsible stewardship of the assets contributed by members, their employers and the State of Illinois.

This report is made available to members of the General Assembly, participating employers, and to other interested persons by request. The participating employers of TRS form a link between TRS and its members. Their cooperation contributes significantly to our success. We hope all recipients of this report find it informa-tive and useful. This report is also available to the general public on our website, https://www.trsil.org.

We would like to take this opportunity to express our gratitude to staff, professional consultants, and others who have worked so diligently to ensure TRS’s successful operation.

Richard Ingram Jana Bergschneider, CPA Executive Director Chief Financial Officer

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BOARD OF TRUSTEES AS OF DECEMBER 1, 2017

Tony Smith, Ph.D. President Superintendent of Education River Forest

Cinda Klickna Vice President Elected Rochester

Mark Bailey Elected Palos Park

Andrew Hirshman Elected Oak Park

Matthew Hower Appointed Barrington Hills

Marc Levine Appointed Wilmette

Laura P. Pearl Appointed Glenview

Fred Peronto Elected Elmhurst

Larry Pfeiffer Elected Carlinville

Daniel Winter Elected Decatur

Randall S. Winters Appointed Highland Park

Introduction - page 13

TRS ORGANIZATION EXECUTIVE CABINET AS OF DECEMBER 1, 2017

BOARD OF TRUSTEES Investment Committee, Audit Committee, Legislative Committee,

Rules & Personnel Committee, Claims Hearing Committee

CHIEF INVESTMENT OFFICER

Stan Rupnik, CFA

CHIEF FINANCIAL OFFICER

Jana Bergschneider, CPA

CHIEF TECHNOLOGY OFFICER

Thomas Smith

CHIEF HUMAN RESOURCES OFFICER

Gina Larkin

CHIEF BENEFITS OFFICER

Carlton W. Lenoir, JD

DIRECTOR OF COMMUNICATIONS

Dave Urbanek

CHIEF LEGAL COUNSEL

Marcilene Dutton, JD

EXECUTIVE DIRECTOR

Richard W. Ingram

Sitting, left to right: Chief Human Resources Officer Gina Larkin, Chief Legal Counsel Marcilene Dutton and Chief Financial Officer Jana Bergschneider Standing, left to right: Director of Communications Dave Urbanek, Chief Technology Officer Thomas Smith, Executive Director Dick Ingram, Chief Benefits Officer Carlton Lenoir and Chief Investment Officer Stan Rupnik

Introduction - page 14

CONSULTING AND PROFESSIONAL SERVICES

ACTUARY Segal Consulting Chicago, Illinois

EXTERNAL AUDITORS (Special assistants to the Office of the Auditor General)

BKD, L.L.P. Decatur, Illinois

INFORMATION TECHNOLOGY Agile Progress, L.L.C. LRWL, Inc. Santa Monica, California Reston, Virginia

Capitol Strategies Promet Source Consulting, Inc. Chicago, Illinois Springfield, Illinois

Towerwall, Inc. DLT Mergerco, L.L.C. Framingham, Atlanta, Georgia Massachusetts

Heat Software USA, Inc. Colorado Springs, Colorado

LEGISLATIVE Leinenweber Baroni & Daffada Consulting, L.L.C. Springfield, Illinois

LEGAL SERVICES Cavanagh & O’Hara Kopec White & Spooner Springfield, Illinois Springfield, Illinois

Holland & Knight, L.L.P. Loewenstein Hagen & Chicago, Illinois Smith, P.C.

Springfield, Illinois Howard & Howard Attorneys, P.L.L.C. Robbins Geller Rudman & Peoria, Illinois Dowd, L.L.P.

San Diego, California Jackson Walker, L.L.P. Austin, Texas

MASTER TRUSTEE State Street Bank and Trust Company Boston, Massachusetts

SECURITIES LENDING AGENT Citibank, N.A. New York, New York

INVESTMENT CONSULTANTS Albourne America, L.L.C. TAVE & Associates, L.L.C. (Absolute return) (Insurance San Francisco, California brokerage services)

Northbrook, Illinois Courtland Partners, Ltd. (Real estate) TorreyCove Capital Cleveland, Ohio Partners, L.L.C.

(Private equity) RVK, Inc. San Diego, California (General investment) Portland, Oregon

CO-INVESTMENT ADVISORS Caledon Capital Stout Risius Ross, Inc. Management, Inc. (Private equity) (Private equity) Los Angeles, California Toronto, Canada

TorreyCove Capital ORG Portfolio Partners, L.L.C. Management, L.L.C. (Private equity) (Real estate) San Diego, California Cleveland, Ohio

Real Asset Portfolio Management, L.L.C. (Real estate) Portland, Oregon

SECONDARY MARKET ADVISORS Greenhill & Co., Inc. New York, New York

Park Hill Group, L.L.C. Chicago, Illinois

UBS Securities, L.L.C. New York, New York

Introduction - page 15

F I N A N C I A L

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Independent Auditor’s Report

Honorable Frank J. Mautino Auditor General State of Illinois and The Board of Trustees Teachers’ Retirement System of Illinois

Report on the Financial Statements

As Special Assistant Auditors for the Auditor General, we have audited the accompanying Statement of Fiduciary Net Position of the Teachers’ Retirement System of the State of Illinois (System), a component unit of the State of Illinois, as of June 30, 2017, and the Statement of Changes in Fiduciary Net Position for the year then ended, and the related notes to the financial statements, which collectively comprise the System’s basic financial statements as listed in the table of contents.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the System’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the System’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the fiduciary net position of the System as of June 30, 2017, and the changes in fiduciary net position for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Financial - page 18

Emphasis of Matter

The actuarially determined pension liability, calculated as required by GASB Statements No. 67, is dependent on several assumptions including the assumption that future required contributions from all sources are made based on statutory requirements in existence as of the date of this report. These assumptions are discussed in Note A.6 of the financial statements. Our opinion is not modified with respect to this matter.

Other Matters

Required Supplementary Information

Accounting principles generally accepted in the United States of America require that management's discussion and analysis, the schedule of changes in the net pension liability, the schedule of net pension liability, the schedule of contributions from employers and other contributing entities, the schedule of investment returns, and notes to required supplementary information as listed in the table of contents be presented to supplement the financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management's responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.

Other Information

Our audit for the year ended June 30, 2017 was conducted for the purpose of forming an opinion on the System’s basic financial statements. The other supplementary information in the financial section and the accompanying introduction, investments, actuarial, and statistical sections, as listed in the table of contents, are presented for purposes of additional analysis and are not a required part of the basic financial statements.

Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the basic financial statements. The other supplementary information in the financial section, as listed in the table of contents, has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the other supplementary information in the financial section, as listed in the table of contents, is fairly stated, in all material respects, in relation to the basic financial statements as a whole for the year ended June 30, 2017.

The System’s basic financial statements for the year ended June 30, 2016 (not presented herein) were audited by other auditors whose report thereon dated December 14, 2016, expressed an unmodified opinion on the System’s basic financial statements. The report of the other auditors dated December 14, 2016, stated that the other supplementary information in the financial section, as listed in the table contents, for the year ended June 30, 2016 was subjected to the auditing procedures applied in the audit of the June 30, 2016 basic financial statements and certain additional auditing procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare those basic financial statements or to those basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America and, in their opinion, was fairly stated in all material respects in relation to the basic financial statements as a whole for the year ended June 30, 2016.

The introduction, investments, actuarial and statistical sections, as listed in the table of contents, have not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide any assurance on them.

Decatur, Illinois December 12, 2017

Financial - page 19

MANAGEMENT’S DISCUSSION AND ANALYSIS This discussion and analysis of the Teachers’ Retirement System of the State of Illinois provides an overview of financial activities for the fiscal year ended June 30, 2017. Please read it in conjunction with the Letter of Transmittal in the Introduction Section on page 6 and the Financial Statements and related notes that follow this discussion.

FINANCIAL HIGHLIGHTS • The net position of TRS at June 30, 2017 was

$49.4 billion.

• During FY17, the net position of TRS increased $4.1 billion.

• Contributions from members, employers, and the State of Illinois were $5.1 billion, an increase of $222 million or 4.6 percent for FY17.

• Total net investment income was $5.5 billion, compared to a $44 million loss for FY16, an increase of $5.6 billion.

• Benefits and refunds paid to members and annuitants were $6.4 billion, an increase of $507 million or 8.5 percent.

• The actuarial accrued liability was $122.9 billion at June 30, 2017.

• The unfunded actuarial accrued liability was $73.4 billion at June 30, 2017. The funded ratio was 40.2 percent at June 30, 2017. The unfunded liability and funded ratio are cal-culated using a smoothed value of assets, as required under Public Act 96-0043.

• The total pension liability was $125.8 billion at June 30, 2017.

• The net pension liability was $76.4 billion at June 30, 2017. The plan fiduciary net posi-tion, as a percentage of total pension liability, was 39.3 percent.

The Financial Statements contained in this sec-tion of the Comprehensive Annual Financial Report consist of:

Statement of Fiduciary Net Position. This state-ment reports the pension trust fund’s net position which represents the difference between the other statement elements comprised of assets and liabil-ities. It is the balance sheet for the pension system and reflects the financial position of the Teachers’ Retirement System as of June 30, 2017.

Statement of Changes in Fiduciary Net Position. This statement details transactions that occurred during the fiscal year. It is the income statement of TRS and reflects the additions and deductions to net position recorded throughout the fiscal year. This statement supports the change in the value of net position reported on the Statement of Fiduciary Net Position.

Notes to the Financial Statements. The notes are an integral part of the financial statements and include additional information not readily evident in the statements themselves.

Required Supplementary Information and Other Supplementary Information. The required supple-mentary information and other financial informa-tion following the notes to the financial statements provide historical and additional detailed informa-tion considered useful in evaluating the pension system’s financial condition.

Financial - page 20

The following are condensed comparative financial statements of the TRS pension trust fund.

CONDENSED COMPARATIVE STATEMENTS OF FIDUCIARY NET POSITION AS OF JUNE 30

Percentage 2017 Change 2016

Cash $38,331,642 (5.7%) $40,637,848

Receivables and prepaid expenses 10,059,591,696 90.5 5,279,564,166

Investments 49,180,275,900 7.8 45,632,926,356

Invested securities lending collateral 3,268,211,165 4.3 3,134,036,175

Capital assets 2,913,530 (19.2) 3,605,993

Total assets 62,549,323,933 15.6 54,090,770,538

Total liabilities 13,173,659,415 49.0 8,839,813,807

Net position restricted for pensions $49,375,664,518 9.1% $45,250,956,731

CONDENSED COMPARATIVE STATEMENTS OF CHANGES IN FIDUCIARY NET POSITION FOR THE YEARS ENDED JUNE 30

2017 Percentage

Change 2016

Contributions $5,064,989,441 4.6% $4,842,319,410

Net investment income /(loss) 5,520,453,001 12,617.1 (44,103,178)

Total additions 10,585,442,442 120.6 4,798,216,232

Benefits and refunds 6,438,005,920 8.5 5,931,207,177

Administrative expenses 22,728,735 (1.0) 22,967,917

Total deductions 6,460,734,655 8.5 5,954,175,094

Net increase /(decrease) in net position 4,124,707,787 (1,155,958,862)

Net position restricted for pensions -beginning of year 45,250,956,731 (2.5) 46,406,915,593 Net position restricted for pensions -end of year $49,375,664,518 9.1% $45,250,956,731

Financial - page 21

FINANCIAL ANALYSIS TRS was created to provide retirement, survi-vor, and disability benefits to qualified members. Increases or decreases in the plan’s net position serve as useful indicators of TRS’s financial posi-tion. The net position available to pay benefits was $49.4 billion at June 30, 2017.

CONTRIBUTIONS Contributions increased $222 million during FY17. During FY17, contributions from the State of Illinois increased $244 million and employer contributions from school districts increased $1.5 million. Member contributions decreased by $23 million due to a reduction in the member contribution rate from 9.4 percent to 9.0 percent. This reduction was due to the expiration of the Early Retirement Option.

The State of Illinois makes appropriations to TRS. Receipts from the State of Illinois increased $244 million in FY17. The increase in FY17 was pri-marily due to changes in actuarial assumptions that were based on the 2015 experience analysis and adopted in the June 30, 2015 actuarial valuation. The 2015 assumption changes did not include a change in the assumed rate of return. State funding law provides for a 50-year funding plan that includes a 15-year phase-in period and a goal of 90 percent funding in the year 2045.

Revenues by Type for the Year Ended June 30, 2017 ($ millions)

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

Investment income

Employe sState ofIllinois

Membe s

$3,986

$929

$5,521

$149

INVESTMENTS The TRS trust fund is invested according to law under the “prudent person rule” requiring invest-ments to be managed solely in the interest of fund participants and beneficiaries. Principles guiding the investment of funds include preserving the long-term principal of the trust fund and maximiz-ing total return within prudent risk parameters.

The TRS investment portfolio returned 12.6 percent, net of fees, for the fiscal year ended June 30, 2017. Total TRS investment assets increased approxi-mately $3.5 billion during the year.

Annual Rate of Return (net of investment expenses)

25%

15%

5% 0

(5%)

(15%)

(25%)

23.6 17.4

12.9 12.8 12.6

0.82008 2009 (5.0)

(22.7)

4.0 0.01 2010 2011 2012 2013 2014 2015 2016 2017

BENEFITS AND REFUNDS Retirement, survivor, and disability benefit pay-ments increased $305 million during FY17. Benefit payments increased to $6.2 billion with 120,151 recipients in FY17. The overall increase in benefit payments is due to an increase in retirement and survivor benefits as well as the number of retir-ees. Retirement benefits were higher as a result of annual increases in retirement benefits and an increase in the number of retirees from 105,937 as of June 30, 2016 to 108,120 as of June 30, 2017.

Refunds of contributions increased $202 million in FY17. The increase during FY17 was the result of members withdrawing refunds they were due following the expiration of the Early Retirement Option.

Financial - page 22

Deductions by Type for the Year Ended June 30, 2017

Retirement benefits 90.7%

Refunds 4.4%

Survivorbenefits 4.1%

Administr tiveexpenses0.3%

Dis bility benefits 0.5%

ACTUARIAL For statutory funding and financial reporting, an actuarial valuation is performed annually and measures the total liability for all benefits earned to date. The actuarial accrued liability is a present value estimate of all benefits earned to date but not yet paid. The actuarial accrued lia-bility based on statutory funding requirements increased $4.3 billion in FY17 to $122.9 billion at June 30, 2017. The actuarial unfunded liability is the present value of future benefits payable that are not covered by the actuarial value of assets as of the valuation date. The actuarial unfunded liability increased $2.0 billion during FY17 to $73.4 billion at June 30, 2017. The funded ratio reflects the percent-age of the actuarial accrued liability covered by the actuarial value of assets. The funded ratio increased from 39.8 percent on June 30, 2016 to 40.2 percent on June 30, 2017.

The actuarial unfunded liability and funded ratio are based on a smoothed value of assets. Public Act 96-0043 requires the five state retirement systems to smooth actuarial gains and losses on investments over a five-year period.

When the funded ratio was based on the fair value of assets, the reported funded ratio was impacted immediately by changes in market conditions. State funding requirements based on fair value assets also were impacted immediately and therefore were more volatile. Using the smoothed value of assets results in more stable reported funded ratios and state funding requirements over time.

Funded Ratio Based on Actuarial Value of Assets

70%

60%

50%

40%

30%

20%

10% 0%

52.1 48.4 46.5 42.1 42.0 39.8 40.240.6 40.6

56.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

The funded ratio in this chart is the ratio of actuarial assets to the actuarial liability. An increase in this ratio indicates an improve-ment in TRS’s ability to meet future benefit obligations. The actu-arial value of assets was based on fair value in 2008 with five-year smoothing beginning in 2009.

During FY14, TRS implemented GASB Statement No. 67, “Financial Reporting for Pension Plans.” As a result of implementing the new statement, TRS is required to disclose the net pension liability and total pension liability in the Financial Statement Notes and Required Supplementary Information in accordance with criteria which differs from criteria used to disclose the actuarial accrued liability and actuarial unfunded liability. The total pension lia-bility is $125.8 billion at June 30, 2017, while the net pension liability is $76.4 billion at June 30, 2017.

Financial - page 23

LEGISLATIVE During FY17, Gov. Bruce Rauner and the General Assembly made a number of significant changes in the Illinois Pension Code that will have a signifi-cant effect on the on-going operations of Teachers' Retirement System.

CREATION OF THE TIER III BENEFIT STRUCTURE A new law creates an optional Tier III hybrid retire-ment plan with two parts – a defined benefit (DB) pension and a defined contribution (DC) plan.

Members who choose the Tier III plan will make payroll contributions to the pension portion based on the cost of their benefit. This contribution will be reviewed and changed, if necessary, every year by the TRS Board. Tier III members will contribute a minimum of 4 percent to the DC portion of the plan. Local school districts, rather than the state, will be required to make employer contributions to both the DB and DC plans.

Based on preliminary planning, TRS anticipates the earliest date that Tier III may be implemented for members is July 1, 2019. The TRS Board will establish the final implementation date of the Tier III plan.

The process of creating Tier III is complicated because TRS has never administered a hybrid retirement plan. Successfully administering a hybrid plan will require substantial modifica-tions within TRS that include enhanced informa-tion technology systems, conversion to employee monthly data reporting and enhanced member communications efforts. Planning, building, testing and implementing all of these changes will be an extensive process.

The new benefit structure does not affect active Tier I members or retired members in any way. There are no changes to Tier I benefits, active mem-ber contributions or health insurance coverage.

CHANGES TO THE STATE’S PUBLIC PENSION SYSTEM FUNDING FORMULA Beginning in FY18, new laws enacted with the state budget will affect the amount of money TRS will receive in the future from state government’s annual contribution to the System:

• TRS must retroactively smooth the fiscal effect of any changes made in actuarial assump-tions (such as the assumed rate of investment return) over a period of five years. The smooth-ing applies to any TRS assumption changes from 2012 on. Up until now, the fiscal impact of such changes were absorbed at one time.

• Local school districts will pay a portion of the cost of a member’s pension if that member’s salary is greater than the governor’s statu-tory salary. The district, not the state, will be responsible for paying the total employer's nor-mal cost on the portion of the member’s salary that exceeds the governor’s statutory salary, which in FY17 was $177,412.

• Beginning on July 1, 2017, employer contri-butions to TRS from special trust and federal funds will be paid at a rate equal to the total employer's normal cost, expressed as a per-centage of payroll.

Financial - page 24

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FINANCIAL STATEMENTS TEACHERS’ RETIREMENT SYSTEM OF THE STATE OF ILLINOIS STATEMENT OF FIDUCIARY NET POSITION JUNE 30, 2017

June 30, 2017 Assets Cash $38,331,642

Receivables and prepaid expenses:

Member contributions 54,778,150 Employer contributions 13,508,665 State of Illinois 492,161,607 Investment income 114,926,644 Pending investment sales 9,381,897,730 Prepaid expenses 2,318,900

Total receivables and prepaid expenses 10,059,591,696

Investments, at fair value:

Fixed income 10,552,182,948 Public equities 17,480,643,235 Alternative investments 19,838,883,828 Derivatives 3,427,917 Short-term investments 1,223,393,259 Foreign currency 81,744,713

Total investments 49,180,275,900

Invested securities lending collateral:

Securities lending collateral 3,222,479,165 Securities lending collateral with the State Treasurer 45,732,000

Total invested securities lending collateral 3,268,211,165 Capital assets, net of accumulated depreciation 2,913,530

Total assets 62,549,323,933

Liabilities

Benefits and refunds payable 8,523,543 Administrative and investment expenses payable 42,699,505 Pending investment purchases 9,854,244,522 Securities lending collateral 3,268,191,845

Total liabilities 13,173,659,415

Net position restricted for pensions $49,375,664,518

See accompanying Notes to Financial Statements.

Financial - page 26

TEACHERS’ RETIREMENT SYSTEM OF THE STATE OF ILLINOIS STATEMENT OF CHANGES IN FIDUCIARY NET POSITION FOR THE YEAR ENDED JUNE 30, 2017

June 30, 2017 Additions Contributions:

Members $929,130,165 State of Illinois 3,986,363,699 Employers

Early retirement 10,776,747 Federal funds 75,694,656 2.2 benefit formula 57,964,519 Excess salary/sick leave 5,059,655

Total contributions 5,064,989,441

Investment income:

Net increase (decrease) in fair value of investments 4,676,047,504 Alternatives income 897,514,621 Interest and dividends 685,696,063 Other investment income 23,479,101 Securities lending income 17,308,948

Less investment expenses: Alternatives expense (428,905,050) Direct investment expense (349,649,601) Securities lending management fees (1,038,585)

Net investment increase 5,520,453,001 Total additions 10,585,442,442

Deductions

Retirement benefits 5,857,968,199 Survivor benefits 263,429,481 Disability benefits 31,470,071 Refunds 285,138,169 Administrative expenses 22,728,735

Total deductions 6,460,734,655 Net increase in net position 4,124,707,787

Net position restricted for pensions

Beginning of year 45,250,956,731

End of year $49,375,664,518

See accompanying Notes to Financial Statements.

Financial - page 27

NOTES TO FINANCIAL STATEMENTS A. PLAN DESCRIPTION 1. REPORTING ENTITY The Teachers’ Retirement System of the State of Illinois (TRS) is the administrator of a cost-sharing, multiple-employer defined benefit public employee retirement system (PERS). Membership is manda-tory for all full-time, part-time and substitute public school personnel employed outside of Chicago in positions requiring licensure. Persons employed at certain state agencies and certain non-government entities also are members. Established by the State of Illinois, TRS is governed by the Illinois Pension Code (40 ILCS 5/16). TRS is a component unit of the State of Illinois and is included in the State’s financial statements as a pension trust fund.

TRS uses criteria established by the Governmental Accounting Standards Board (GASB) to deter-mine whether other entities should be included within its financial reporting entity. Based on the criteria, TRS includes no other entities in these financial statements.

2. EMPLOYERS Members of TRS are employed by school districts, special districts, certain state agencies and certain non-government entities. Each employer remits member contributions to TRS. Employers are respon-sible for employer contributions for teachers paid from federal funds and employer contributions for the 2.2 formula increase. As a result of Public Act 94-0004, which became law on June 1, 2005, employers are also required to pay the cost of pen-sion benefits resulting from salary increases of more than 6 percent. Public Act 94-1057, which became law on July 31, 2006, provides additional exemp-tions from employer contributions for excess salary increases. Some of these exemptions are perma-nent while others were available for a limited time period. Employers also pay a contribution for sick leave days granted in excess of the member’s nor-mal annual allotment and used for service credit at retirement. The contributions do not apply to salary increases awarded or sick leave granted under con-tracts or collective bargaining agreements entered into, amended, or renewed prior to June 1, 2005. In addition, the State of Illinois is a nonemployer

contributing entity that provides employer contribu-tions on behalf of the System’s employers. For infor-mation about employer contributions made by the State of Illinois, see “Schedule of Contributions from Employers and Other Contributing Entities” within the Required Supplementary Information (RSI) sec-tion of this report.

Number of Employers (as of June 30)

2017 Local school districts 850

Special districts 125

State agencies 14

Total 989

3. MEMBERS TRS Membership (as of June 30)

2017

Retirees and beneficiaries 120,151

Inactive members 131,812

Active members 160,488

Total 412,451

4. BOARD OF TRUSTEES TRS is governed by a 13-member Board of Trustees. Trustees include the state superintendent of edu-cation, six trustees appointed by the governor, four trustees elected by contributing TRS members, and two trustees elected by TRS annuitants.

The president of the Board of Trustees, by law, is the Illinois superintendent of education. The Board of Trustees elects its vice president from among its members. The Board of Trustees appoints an execu-tive director who also serves as the secretary of the Board of Trustees. The executive director is responsi-ble for daily operations at TRS.

5. BENEFIT PROVISIONS Governed by the Illinois Pension Code (40 ILCS 5/16), which is subject to amendment by the Illinois General Assembly and approval by the governor, TRS provides retirement, death and disability benefits. Membership is mandatory for all full-time, part-time, and substitute public school personnel employed in Illinois outside the city of Chicago.

Financial - page 28

Public Act 96-0889, which was signed into law in the spring of 2010, added a new section to the Pension Code that applies different benefits to anyone who first contributes to TRS on or after January 1, 2011 and does not have any previous service credit with one of the reciprocal retirement systems in Illinois. Members who first participate on or after that date are members of Tier II.

The act does not apply to anyone who made contri-butions to TRS prior to January 1, 2011. They remain participants of Tier I.

Another tier was created in July 2017, Tier III. It is a hybrid retirement plan with both a defined benefit and defined contribution plan. The earliest imple-mentation date will be July 2019.

TIER I BENEFITS A member qualifies for an age retirement annuity after meeting one of the following requirements: age 62 with five years of service credit; age 60 with 10 years; or age 55 with 20 years. If a member retires between the ages of 55 and 60 with fewer than 35 years of service, the annuity will be reduced at the rate of 0.50 percent for each month the mem-ber is under age 60. A member with fewer than five years of creditable service and service on or after July 1, 1947, is entitled to a single-sum benefit pay-able at age 65.

A retirement benefit is determined by the average of the four highest consecutive years of creditable earn-ings within the last 10 years of creditable service and the percentage of average salary to which the mem-ber is entitled. Most members retire under a formula that provides 2.2 percent of final average salary up to a maximum of 75 percent with 34 years of service. The 2.2 percent formula became effective July 1, 1998 but service earned before that date can be upgraded to the 2.2 formula with a member contribution. The cost of the upgrade can be reduced if members upgrade and continue teaching after 1998. A gradu-ated formula applies to service earned before 1998 and provides a maximum benefit of 75 percent of average salary with 38 years of service.

Tier I members who contributed to TRS before July 1, 2005 receive a money purchase (actuarial)

benefit if it provides a higher benefit than the 2.2 or graduated formulas. The 75 percent cap does not apply to the money purchase benefit.

All Tier I retirees receive an annual 3 percent increase in the current retirement benefit beginning January 1 following the attainment of age 61 or on January 1 following the member’s first anniversary in retire-ment, whichever is later.

Disability and death benefits are provided.

If a member leaves covered employment, TRS will refund a member’s retirement contributions upon request. The refund consists of actual contributions, excluding the 1 percent death benefit contribution.

Effective July 1, 2017, Tier I members contribute 9.0 percent of their creditable earnings to TRS and an additional contribution to a retiree health insurance program that is not administered by TRS.

TIER II BENEFITS Changes from Tier I include raising the minimum eligibility to draw a retirement benefit to age 67 with 10 years of service. A discounted annuity can be paid at age 62 with 10 years of service. The Tier II law caps creditable earnings and contributions used for retirement purposes at a level that is lower than the Social Security Wage Base. Tier II annual increases will be the lesser of 3 percent of the original benefit or ½ percent of the rate of inflation begin-ning January 1 following attainment of age 67 or on January 1 following the member’s first anniversary in retirement, whichever is later.

The 2.2 retirement formula also applies to Tier II but the final average salary is based on the highest con-secutive eight years of creditable service rather than the highest consecutive four years of salary. The single-sum benefit is also payable at age 65 to Tier II members with fewer than five years of service. The money purchase (actuarial) benefit is not available to Tier II members.

Disability and refund provisions for Tier II are iden-tical to those that apply to Tier I. Death benefits are payable under a formula that is different from Tier I.

Financial - page 29

Effective July 1, 2017, Tier II members contribute 9.0 percent of their creditable earnings to TRS and an additional contribution to a retiree health insur-ance program that is not administered by TRS.

TIER III BENEFITS Created in July of 2017, the Tier III benefit is a hybrid retirement plan with two parts – a defined bene-fit (DB) pension and a defined contribution (DC) plan. TRS anticipates the earliest date that Tier III may be implemented for members is July 1, 2019. The TRS Board will establish the final Tier III plan implementation date.

All new TRS members on or after the date Tier III is implemented will be enrolled in Tier III and have the option to switch to Tier II. In addition, after the implementation date all existing Tier II members will have the choice to join Tier III permanently.

Tier III members will make payroll contribu-tions to their DB pensions that are based on the full cost of this part of the benefit, but no more than 6.2 percent of salary. The DB contribution rate for Tier III members will be re-evaluated annually. Tier III members will contribute a mini-mum of 4 percent of their pay to the DC portion of the plan.

The normal retirement age for Tier III is determined by Social Security rules, but it will be no earlier than age 67.

The Tier III calculation for an initial pension is ser-vice credit multiplied by final average salary multi-plied by 1.25 percent. The final average salary used in the initial pension calculation is the member’s average salary during the last 10 years of service.

The automatic annual increase for Tier III is sim-ilar to the Tier II automatic increase – one-half of the previous year’s consumer price index, not compounded. However, unlike the Tier II auto-matic increase, the Tier III increase does not have a 3 percent cap.

Local school districts, rather than the state, will contribute the employer contributions to both the DB and DC plans in Tier III. Under the

current law, beginning in FY 2021, school districts will pay 2.58 percent annually of their TRS mem-ber salaries to the System for the DB portion and between 2 percent and 6 percent of each individual member’s pay to the System for the DC portion.

6. ACTUARIAL MEASUREMENTS The Schedule of Changes in the Net Pension Liability, Schedule of the Net Pension Liability, and the Schedule of Contributions from Employers and Other Contributing Entities may be found in the Required Supplementary Information. Other schedules per-taining to the System’s funded status are in the Actuarial section.

Member, employer, and state contributions are statutorily defined by the Illinois Pension Code (40 ILCS 5/16), which is subject to amendment by the Illinois General Assembly with approval by the gov-ernor. Since July 1, 1995, state appropriations have been made through a continuing appropriation.

Member contributions are allocated as follows: 7.5 percent for retirement; 0.5 percent for post-retire-ment increases; and 1 percent for death benefits.

Employer contributions are made by or on behalf of employers from several sources. The State of Illinois provides the largest source of contributions through state appropriations from the Common School Fund. Employers also make contributions for the 2.2 benefit formula and for teachers who are paid from fed-eral funds. Additionally, employers contribute their portion of any excess salary increase or sick leave costs due.

State funding law provides for a 50-year funding plan that includes a 15-year phase-in period.

Public Act 96-0043, which was effective July 15, 2009, requires TRS to use a five-year smoothing method for asset valuation beginning on June 30, 2009. State contribution requirements were first affected by this change in FY11.

Administrative expenses are budgeted and approved by the TRS Board of Trustees. Funding for these expenses is included in the employer contribution, as determined by the annual actuarial valuation.

Financial - page 30

PENSION LIABILITY The actuarial assumptions included in the June 30, 2017 actuarial valuation were used to calculate the June 30, 2017 total pension liability. The same assumptions were used to calculate the June 30, 2016 total pension liability. The invest-ment return assumption for both years is based on a 2014 asset allocation study conducted by the TRS investment consultant and additional analyses con-ducted by the TRS actuary in 2015, 2016 and 2017. The results of the investment consultant's 2017 asset allocation study will be reflected in the June 30, 2018 valuation.

As of June 30, 2017, the assumption for future investment returns was 7.0 percent, a rate unchanged from June 30, 2016. GASB Statement No. 67 requires a different rate to be used to dis-count future benefit streams if assets are insuffi-cient to cover payments to current participants. Since assets were sufficient for this purpose, the June 30, 2017 total pension liability discount rate was 7.0 percent. The June 30, 2016 total pension lia-bility discount rate was 6.83 percent.

The TRS actuary used the following assumed rates of returns by asset class, excluding 2.50 percent for the assumed rate of inflation and excluding investment expenses.

Expected Arithmetic Real Returns Over 20 Years

Asset Class Allocation Return

U.S. equities large cap 14.4% 6.94%

U.S. equities small/mid cap 3.6 8.09

International equities developed 14.4 7.46

Emerging market equities 3.6 10.15

U.S. bonds core 10.7 2.44

International debt developed 5.3 1.70

Real estate 15.0 5.44

Real return 11.0 4.28

Absolute return 8.0 4.16

Private equity 14.0 10.63

If the plan’s assets are not sufficient to cover all benefit payments to current plan members, GASB Statement No. 67 requires the discount rate to

be a blended rate, which includes the long-term expected rate of return and a municipal bond rate (the S & P Municipal Bond 20-Year High Grade Rate Index) as of the end of the current fiscal year. Based on the following projections, the System can use the long-term expected rate of return as the dis-count rate for the year ended June 30, 2017.

TRS, with the assistance of the System's actuary, projected that the Plan’s fiduciary net position will be sufficient to provide for all benefit payments to current plan members. Projected contributions assume that all statutorily required contributions are made through FY2119 including projected contributions from members, employers, and the State of Illinois (nonemployer contributing entity). Projected state contributions reflect the funding changes enacted in Public Acts 100-0023 and 100-0340. However, the projections do not include any assumptions about the utilization of Tier III under PA 100-0023.

Estimated contributions from employers and the State of Illinois, of which the majority of the contri-butions (approximately 95 percent) are provided by the State of Illinois, are projected to be $4.1 billion in 2018, $4.5 billion in 2019 and grow to $10.6 billion by 2045 based on current statutory requirements for current members. Tier I’s liability is partially funded by Tier II because the Tier II contributions are higher than the cost of Tier II benefits. Due to this subsidy, contributions from future members in excess of the service cost are also included in the determination of the discount rate.

The actuarial cost method required for financial reporting purposes is the entry age normal method. For TRS, total pension liability (TPL) is developed and rolled forward to the fiscal year end based on a valuation date and member census one year prior. TPL is projected to the June 30, 2017 measurement date based on census data as of June 30, 2016. Assets, referred to as plan fiduciary net position, are measured at fair value.

Financial - page 31

Net Pension Liability Assumptions Used for Financial Reporting

June 30, 2017

Total pension liability $125,773,806,438

Plan fiduciary net position 49,375,664,518

Net pension liability $76,398,141,920

Plan fiduciary net position as a percentage of the total pension liability 39.3%

Sensitivity of the Net Pension Liability to Changes in the Discount Rate

1% Decrease Current 1% Increase

Discount rate 6.00% 7.00% 8.00%

Net pension liability $93,865,095,009 $76,398,141,920 $62,091,251,142

The actuarial assumptions used in the June 30, 2017 and June 30, 2016 actuarial valuations were the same. In the June 30, 2016 actuarial valuation, the Board of Trustees lowered the assumed rate of return from 7.5 percent to 7.0 percent and reduced the assumed inflation rate from 3.0 percent to 2.5 percent. The reduction in the inflation assumption also reduced assumptions for salary increases and Tier II salary caps and post-retirement cost-of-living increases. Most of the other actuarial assumptions are based on the actu-arial experience analysis dated August 2015 that cov-ered the period July 1, 2011 through June 30, 2014. Its recommendations were adopted in the June 30, 2015 actuarial valuation.

Disclosure and the Actuarial Valuation

Actuarial Valuation Date June 30, 2017

Census Date: June 30, 2016 with total pension liability projected to June 30, 2017

Actuarial Cost Method:

For financial reporting Entry age normal purposes

Asset Valuation Method: For financial reporting Fair value as of valuation date

purposes

Actuarial Assumptions: Investment rate of return 7.0% on earnings after

June 30, 2016 Real rate of investment 4.5%

return Projected salary increases 9.25% with 1 year of service

to 3.25% with 20 or more years of service. Includes inflation and real wage growth (productivity) assumptions.

Group size growth rate 0% Assumed inflation rate 2.5% Real wage growth 0.75%

(productivity) Post-retirement increase Tier I: 3%, compounded;

Tier II: 1.25%, not compounded

Mortality table: RP - 2014 with future mortality improvements on a fully generational basis using projection table MP-2014.

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B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. BASIS OF ACCOUNTING The financial transactions of TRS are recorded using the economic resources measurement focus and the accrual basis of accounting. Member and employer contributions are recognized as revenues when due pursuant to statutory or contractual requirements. Benefits and refunds are recognized as expenses when they are due and payable in accordance with the terms of the plan.

2. USE OF ESTIMATES The preparation of financial statements in confor-mity with accounting principles generally accepted in the United States of America requires manage-ment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of additions to and deductions from net position during the reporting period. Actual results could differ from these estimates. TRS uses an actu-ary to determine the total pension liability for the defined benefit plan and to determine the actuarial-ly-required contribution.

3. RISKS AND UNCERTAINTIES TRS investments are diversified and include vari-ous investment securities. Investment securities are exposed to a variety of risk including credit, market and interest rate risk. Due to the level of risk associ-ated with certain investment securities, it is at least reasonably possible that value changes will occur in the near-term and such changes could materially affect the amounts reported in the Statement of Fiduciary Net Position.

4. NEW ACCOUNTING PRONOUNCEMENTS GASB Statement No. 75, “Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions,” was established to improve accounting and financial reporting by state and local govern-ments for postemployment benefits other than pen-sions (other postemployment benefits of OPEB) and

improves information provided by state and local gov-ernmental employers about financial support for OPEB that is provided by other entities. TRS is currently evaluating the financial statement impact of GASB Statement No. 75. If applicable, this statement will be implemented for the year ended June 30, 2018.

5. METHOD USED TO VALUE INVESTMENTS TRS reports investments at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value for publicly traded real return funds, equities, foreign currency and exchange traded derivatives is determined by using the closing price listed on national securities exchanges as of June 30. Fair value for the majority of fixed income securities and over-the-counter derivatives is determined primarily by using quoted market prices provided by independent pricing services. Short-term investments are gener-ally reported at amortized cost, which approximates fair value. Appraisals are used to determine fair value on directly-owned real estate investments. Fair value for private equity investments, absolute return funds, non-publicly traded real return funds and partnership interests in real estate funds is determined by TRS staff and the general partners or investment managers in accordance with the provisions in the individual agree-ments. These agreements also require that an inde-pendent audit be performed on an annual basis.

6. CAPITAL ASSETS Equipment is stated on the basis of historical cost. Depreciation is computed using the straight-line method based upon the estimated useful lives of the assets. Capital assets activity for the year ended June 30, 2017 was as follows:

Financial - page 33

Beginning Balance

Additions/ Transfers

In

Disposals/ Transfers

Out Ending

Balance

payable for the year ended June 30, 2017 was as follows:

Land $235,534 $ - $ - $235,534

Mineral Lease Rights 2,643 - - 2,643

Office building 8,003,961 87,762 - 8,091,723

Site improvement 1,088,635 - - 1,088,635

Equipment and furniture 2,687,900 131,018 41,925 2,776,993

Software 1,991,996 154,742 - 2,146,738

14,010,669 373,522 41,925 14,342,266

Less accumulated depreciation:

Office building 6,281,236 431,261 - 6,712,497

Site improvement 682,588 67,082 - 749,670

Equipment and furniture 2,410,897 320,670 41,925 2,689,642

Software 1,029,955 246,972 - 1,276,927

10,404,676 1,065,985 41,925 11,428,736

Total $3,605,993 ($692,463) $ - $2,913,530

The estimated useful lives for depreciable capital assets are as follows: Office building and site improvements ($25,000 or greater capitalized) 10-40 years Equipment and furniture ($5,000 or greater

capitalized) 3-10 years Software ($25,000 or greater capitalized) 3-5 years

Beginning Balance Additions Reductions

Ending Balance

Compensated absences payable $1,958,269 $1,001,732 $997,114 $1,962,887

The estimated amount due within one year is: $75,556

8. RECEIVABLES Receivables consist primarily of 1) member and employer contributions owed and yet to be remit-ted by the employing districts, 2) interest, divi-dends, real estate and private equity income owed to TRS, 3) appropriations not yet received from the State of Illinois as of June 30, and 4) pending investment sales.

TRS assesses penalties for late payment of contri-butions and may collect any unpaid amounts from the employing districts by filing a claim with the appropriate regional superintendent of education or the Office of the Comptroller against future state aid payments to the employer. TRS considers these amounts to be fully collectible.

9. RISK MANAGEMENT 7. COMPENSATED ABSENCES When employment is terminated, TRS employees are entitled to receive compensation for all accrued unused vacation time and one-half of all unused sick leave earned through December 31, 1997. (Lump-sum payments for sick leave earned prior to January 1, 1984, are subject to a maxi-mum of 60 days or 420 hours.) Sick time earned after December 31, 1997 is not compensable at termination.

At June 30, 2017, the System had a liability of $1,962,887 for compensated absences. The liabil-ity is included in administrative and investment expenses payable on the Statement of Fiduciary Net Position. For non-investment staff, the increase or decrease in liability is reflected in the financial statements as administrative expense. For invest-ment staff, the increase or decrease is reflected as investment expense. Compensated absences

TRS, as a component unit of the State of Illinois, provides for risks of loss associated with workers’ compensation and general liability through the State’s self-insurance program. TRS obtains com-mercial insurance for fidelity, surety and property. No material commercial insurance claims have been filed in the last three fiscal years.

C. CASH Custodial credit risk for deposits is the risk that, in the event of a bank failure, TRS’s deposits may not be returned. TRS has a formal policy to address cus-todial credit risk. The policy is designed to minimize custodial credit risk through proper due diligence of custody financial institutions and investment advi-sors; segregate safekeeping of TRS assets; estab-lish investment guidelines; and work to have all investments held in custodial accounts through an agent, in the name of custodian’s nominee, or in a

Financial - page 34

corporate depository or federal book entry account system. For those investment assets held outside of the custodian, TRS will follow the applicable regulatory rules.

The non-investment bank balance and carry-ing amount of TRS’s deposits was $38,331,642 at June 30, 2017. Of the ba